Chapter 2- Thinking Like an Economist.docx

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School

Ryerson University

Department

Economics

Course

ECN 104

Professor

Paul Missios

Semester

Fall

Description

CHAPTER 2: THINKING LIKE AN
ECONOMIST
THE SCIENTIFIC METHOD: OBSERVATION, THEORY AND MORE OBSERVATION
-economists must make do with whatever data the world happens to give them
-they play close attention to the natural experiments offered by history
The Scientific Method: the systematic pursuit of knowledge through the formulation of a problem,
collection of data, and the formulation and testing of hypotheses.
It consists of a number of elements: elements:
• Observation of facts (real world data)
• The formulation of possible explanations of cause and effect (hypotheses)
• The testing of these explanations (hypothesis)
• The acceptance, rejection or modification of the hypotheses.
• As favorable results accumulate, the hypotheses evolve into theory, law or principle (sometimes referred
to a model)
THE ROLE OF ASSUMPTIONS
-assumptions are made to simplify the complex world for easier understanding
-the art in scientific thinking is deciding which assumptions to make
-economists use different assumptions in terms of short-run and long-run effects
Ceteris Paribus (Other Things Equal): It is assumed that all other variables except those under
immediate consideration are held constant for a particular analysis.
ECONOMIC MODELS
-economists use diagram and equation models to learn about the world
-economic models omit the details to better understand what is truly important
-all models are built with assumptions and does not include every feature of the economy
THE CIRCULAR –FLOW DIAGRAM (P. 25)
Circular-flow diagram: a visual model of the economy that shows how dollars flow through the
markets among household and firms
-Firms produce goods and services using inputs. Ex. labour, land (natural resources), and capital
(buildings and machines) -inputs= factors of production (households own factors of production and consume what the firms
produce)
-Households and firms interact in two types of markets:
Markets for goods and services
-households -> buyers
-firms -> sellers
Markets for the factors of production
-households -> sellers
-firms -> buyers
-inner loop shows the corresponding flow of inputs and outputs
-outer loop shows the flow of dollars
THE PRODUCTION POSSIBILTIES FRONTIER
Production possibilities frontier: a graph that shows the combinations of output that the economy can
possibly produce given the available factors of production and the available production technology
-With the resources it has, the economy can produce at any point on or inside the production possibilities
frontier, but it cannot produce at points outside the frontier
-inside: possible, but inefficient
-outside: impossible
-point on curve: possible, efficient
-outcome is considered efficient if the economy is getting all it can from scarce resources it has available
-economy can produce any combination on or inside the frontier
-there is a point when society faces a tradeoff; the on